The current account-interest rate relation: A panel data study for OECD countries

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1 E3 Journal of Busness Managemen and Economcs Vol. 3(2). pp , February, 2012 Avalable onlne hp:// ISSN E3 Journals 2012 Full lengh research paper The curren accoun-neres rae relaon: A panel daa sudy for OECD counres Melha ENER and Feyza ARICA* Deparmen of Economcs, Canakkale Onsekz Mar Unversy Acceped 10 January, 2012 The ssue of he curren accoun s mporan for polcy makers, snce provdes nformaon abou quany of foregn resources ha mus be borrowed o fund domesc nvesmen. Ths sudy examnes he relaonshp beween curren accoun balance as a percenage of GDP and real neres rae over he perod from for a sample of 21 OECD counres ha are hgh ncome economes usng recen developed panel esmaon echnques. The wo-way panel esmaon echnque s used n order o nvesgae he relaonshp beween he seleced varables. The wo-way Panel OLS esmaon resuls show ha here s a posve relaonshp beween curren accoun and real neres rae as expeced. Ths fndng llusraes he fundamenal undersandng of he role of real neres rae n deermnng he curren accoun balance for hgh ncome economes, and s useful for polcy consderaons. From polcy perspecve, we can say ha he auhores can overcome curren accoun mbalances by alerng neres raes. Keywords: Moneary polcy; Curren accoun mbalances; Real neres rae; The Two- way Panel Daa Model JEL Classfcaon Codes: C23, E43, E52, F32 INTRODUCTION In macroeconomcs, curren accoun s descrbed as he dfference beween naonal savngs and nvesmens, whch are funcons of neres rae. Curren accoun mbalances are always a concern for macro polcymakers snce curren accoun mbalances can lead o balance of paymen crses. The sze of a counry s curren accoun s an mporan sgn of economc acvy. Curren accoun mbalances supply nformaon abou quany of foregn resources ha mus be borrowed o fund domesc nvesmen (Boleau and Normandn, 2004). Furhermore, he curren accoun also saes wha s raded wh oher counres, and s a good reflecve ndcaor of each *Correspondng Auhor emal: feyzarca@gmal.com counry n deermnng comparave advanage n he global economy. The curren accoun defc occurs wh varous reasons n a counry. The reasons consung he curren accoun defc canno always be negave. Balanchard and Mles- Fere (2011) examned hese reasons as good and bad reasons. We can summarze hese reasons as follows: he frs bad reason ha plays a role n generang he curren accoun defc s msbehavor of fscal auhores decreasng naonal savng and he second s fnancal regulaon falures causng serous developmens n cred volume (Balanchard and Mles- Fere, 2011). Some reasons causng he curren accoun defc can be evaluaed as good reasons conrarly o he bad reasons. The frs good reason affecng he curren accoun defc s emporarly low expor prces, and he

2 Melha and Feyza. 049 second s brgh fuure economc prospecs, causng o low savng. The hrd good reason s o lead o hgh nvesmen by ncreasng he margnal produc of capal (Balanchard and Mles-Fere, 2011). Increased domesc demand and deeroraon n fscal poson can be shown as he man facors ha have rggered he curren accoun defc oher han neres rae. Budge defc s one of he fundamenal varables affecng he curren accoun defc and has a posve mpac on he curren accoun defc. The Mundell- Flemng model proposes ha ncreases n he fscal defc lead o curren accoun defc by rasng domesc neres raes, he exchange rae, and he rae of capal nflows (Bzs e al., 2008). Bu we have focused on neres raes as he major facor ha has mpac on he curren accoun n hs sudy. Changes n he neres raes have mpac on balance of paymen hrough real demand for money. The demand for real money reduces due o he fac ha he rse n he neres raes would ncrease he cos of keepng he money. Ths encourages he purchase of domesc and foregn secures ogeher wh oher domesc and foregn good purchase. Also, ncreased he neres rae encourages foregn capal nflows as well. The effecs of hese developmens wll depend on he amoun of an ncrease n mpor and a decrease n expor orgnaed from a decreases demand for money ogeher wh he developmens n he amoun of foregn capal enerng o he counry. If he foregn capal canno ener he counry a he same amoun, hen he balance of paymen wll be n defc. Bu, hs explanaon of monearss conradcs wh Keynesan explanaons. Accordng o Keynesans an ncrease n he neres raes reduces boh aggregae ncome and expendure, and herefore nduces o close o he balance of paymen defcs (Akdş, 2006). The remander of he sudy s organzed as follows. Secon II revews he leraure subjeced he relaon beween curren accoun and neres raes. Secon III presens daa and deals abou emprcal mehodology used n hs paper. Esmaon resuls are presened n secon IV followed by conclusons n secon V. Ths paper also provdes readers wh references. REVIEW OF LITERATURE Balance of paymens sascs are a prmary nsrumen for he analyss of a counry s exernal suaon. The balance of paymens provdes useful nformaon across a broad specrum of economc polcy needs. The balance of paymens summarzes for a specfc me perod, he economc ransacons of an economy wh he res of he world ransacons essenally beween resdens and non-resdens; conss frsly of hose nvolvng goods, servces, ncome and curren ransfers. These are summarzed by he BOP curren accoun. The curren accoun balance measures he dfference beween he value of expors and mpors of goods, servces, facor ncome flows and ransfers (O Malley, 2001): CAB=X- M+NY+NCT=S-I Where CAB = The BOP curren accoun balance; S= Domesc Savngs; I= Invesmen; X= Expors of goods and servces; M= Impors of goods and servces; NY= Ne ncome from abroad; NCT= Ne curren ransfers from abroad The magnude of a counry s curren accoun s an mporan sgn of economc acvy. However, dependng on he naon s sage of economc growh, s ams, and he mplemenaon of s economc program, he sae of he curren accoun s varable wh respec o he characerscs of he counry. Analyzng a curren accoun defc or surplus s crucal o know wha s fuelng he exra deb and wha s beng done o couner he effecs. Furhermore, he curren accoun also saes wha s raded wh oher counres, and s a good reflecve ndcaor of each counry n deermnng comparave advanage n he global economy (Heakal, 2009). Curren accoun can be expressed n he wo defnons. The frs one s he dfference beween he value of expors of goods and servces and he values of mpors of goods and servces. The second one s he dfference beween naonal savngs and nvesmen. If he curren accoun defc reflecs an excess of mpors over expors, hen may be ndcave of compeveness problem, bu because he curren accoun defc also means low savngs raher han hgh nvesmen, could equally be ponng o a hghly producve, growng and developng economy. Or could reflec reckless fscal polcy, or a consumpon bnge (Ghosh and Ramakrshnan, 2006). On he oher hand, accordng o Edwards (2002) boh savngs and nvesmen decsons are based on neremporal facors such as lfe cycle consderaons and expeced reurns on nvesmen projecs. Therefore, he curren accoun s an neremporal phenomenon (Edwards, 2002). Smlarly, accordng o Sachs (1981) hgher curren accoun defcs can reflec new nvesmen opporunes. Curren accoun has been affeced by many facors such as he expecaons, fscal polcy, and producvy shocks. Snce curren accoun mbalances reflec neremporal choces, expecaons of fuure evens can be an mporan facor n deermnng he sze of he curren accoun defcs and surpluses. Smlarly, many economss and polcymakers sugges ha here exss he lnk beween he changes n fscal polcy and he changes n he curren accoun. The wo defcs were called as wn defcs because boh he defcs move n

3 050 E. J. Bus. Manage. Econ. he same drecon. Fscal polcy can affec he curren accoun hrough he channels of neres raes and counry rsk prema. Deflaonary fscal polces have effec n drecon of decrease neres raes, hereby mprovng he curren accoun balance. A drop n rsk prema can smulae capal nflows, whch can boos demand and real apprecaon pressures and worsen he curren accoun (Abbas e al., 2010). Mohammad (2004) found ha larger governmen budge defcs lead o larger curren accoun defcs. Chen (2007) suggess he exsence of a long run relaonshp beween budge defcs and neres rae and beween budge defcs and rade defcs. A permanen producvy shocks and ransory producvy shocks affec he curren accoun balance n dfferen drecon. Permanen producvy shocks may generae an ncrease n nvesmen and a declne n savngs, hence hey may worsen he curren accoun defc. Unlke, ransory shock ha may move he curren accoun no surplus snce here may be no nvesmen response o emporary producvy shocks (Glck and Rogoff, 1995; Obsfeld and Rogoff, 1995; Calderon e al. 1999). The classc curren accoun records he neres paymens excludng he real capal losses orgnang from he ncrease of prce level receved by credors. A rse n nflaon fully mached by a rse n neres raes causes a rse n neres ncome for a credor counry ha s exacly offse by greaer capal losses. Snce he ncreased neres ncome s recorded n he curren accoun, he measured curren accoun surplus rses. Conrarly, debor counres have a lower curren accoun balance under nflaonary condons han hey have ensured sable prces n her economy because he accouns do no show her real gan on ousandng deb (Sachs, 1981). Bu he subjec we wan o nvesgae s wheher he relaonshp exss beween curren accoun and neres rae. There are rarely economerc sudes whch conan hs relaonshp alhough here s a wde range of leraure on he relaonshp beween curren accoun and neres rae. Generally, he radonal sudes analyzng hs relaonshp ndcae ha an ncrease n real neres rae rases savngs and reduces nvesmen and hence mproves curren accoun balance. However, here s no agreemen abou hs relaonshp. There are mxed fndngs relaed wh hs relaonshp n he leraure. Obsfeld and Rogoff (2000) used neremporal model o examne he relaonshp beween he curren accoun and neres raes and found ha movemens n curren accoun have negave effec on neres raes n he presence of ransacon coss under assumpon of perfec capal mobly. Bergn and Sheffrn (2000) and Bernhardsen (2000) proved ha here s a posve relaonshp beween curren accoun and real neres rae, ha s, an ncrease n he real neres rae rgger an ncrease n curren accoun balance. Lane and Mles-Ferre (2002) nvesgaed he relaonshp among curren accoun, counry rsk, and real neres rae dfferenals. They found ha he counry rsk and neres rae dfferenal have sgnfcan effec on curren accoun. Rubaszek (2010) analyzed he role of he lendng-depos neres rae spread on he curren accoun n 60 developng counres. Rubaszek (2010) proved he presence of a sgnfcan relaonshp beween he curren accoun and he neres rae. Calderon e al., (1999) found negave assocaons beween he nernaonal real neres rae and he curren accoun defc and beween growh raes and he curren accoun defcs n developng counres seleced. Accordng o her esmaes, a emporary rse n nernaonal real neres raes of 1 percenage pon leads o a curren accoun defc reducon of abou 0.18 percenage pons. Kormend and Proopapadaks (2005) examned he mpac of budge defcs on real neres raes and curren accoun balance. They found no evdence n favor of convenonal effecs of budge defc n eher real neres raes or curren accoun defcs. Anoruo and Elke (2008) examned he asymmerc relaonshp beween curren accoun and neres raes for Inda, Korea, Phlppnes, and Thaland usng he nonlnear un roo es and conegraon procedures. The resuls ndcaed ha changes n curren accoun respond sgnfcanly o posve shocks o changes n neres rae for Inda, Korea, and Phlppnes whereas curren accoun responds negavely o shocks n neres rae for Thaland. Herrmann and Jochem (2005) nvesgaed he deermnans of he curren accoun defcs by usng he varables of per capa ncome, exchange raes, neres raes, nvesmen demand, fscal defcs for Cenral and Easern Europe counres. Ther resuls ndcae ha an ncrease n he budge defc conrbues o he deeroraon of he curren accouns of he Cenral and Eas European EU member saes. Smlarly, he real neres raes have posve sgn and he ne effec of he money o GDP rao s also a posve sgn on he curren accoun n relaonshp o GDP. On he oher hand, was found ha nvesmen rao has he expeced negave sgn on he curren accoun n relaon o GDP. Daa The daa used n hs sudy conss of annual observaons on curren accouns o GDP rao and real neres raes for Ausrala, Belgum, Canada, Denmark, Fnland, France, Germany, Greece Iceland, Ireland, Ialy,

4 Melha and Feyza. 051 Japan, Korea, Neherlands, New Zealand, Norway, Porugal, Sweden, Swzerland, Uned Kngdom, and Uned Saes over he perod of The depos neres rae adjused for nflaon as measured by he GDP deflaor s used as real neres rae. To esmae he relaonshp beween he curren accoun and real neres raes, we use he followng model: CA = β0 + β1. r n + u (1) Where CA s he curren accoun balance n counry and year, r n s real neres raes, and u s an error erm. Real neres rae s obaned by subracng he nflaon rae from he depos rae. The daa used n are aken from he World Economc Oulook Daabase, Ocober 2010 released by he Inernaonal Moneary Fund as well as he World Developmen Indcaors daabase of he World Bank. METHODOLOGY Panel Un Roo Tess In order o oban unbased esmaons, we nvesgaed he exsence of un roo n he seres. Several dfferen panel un roo ess are avalable. Panel un roo esng emerged from me seres un roo esng. The major dfference o me seres esng of un roos s ha we have o consder asympoc behavor of he me-seres dmenson T and he cross-seconal dmenson N (Nell and Zmmermann, 2011). We have used he approaches of Im e al., (2003); Augmened by Phllps and Perron (1988); Levn e al., (2002). These are denoed by IPS, ADF-Fsher, PP- Fsher, and LLC, respecvely. The LLC sasc allows for heerogeney of ndvdual deermnsc effecs and seral correlaon srucure of he error erms assumng homogeneous frs order auoregressve parameers. LLC assume homogeneous auoregressve coeffcens beween ndvdual,.e. β = β for all, and es he null hypohess H0 : β = β = 0 agans he alernave H : β = β p 0 for all. To sum up, LLC sugges he A followng hypoheses H each me seres conans a un roo 0 : H1 : each me seres s saonary The srucure of he LLC analyss may be specfed as follows: p j Y = α + β. Y + δ. τ + φ. Y + u,, 1 j, j j= 1 Where = 1,, N = 1,,T τ denoes rend, α denoes ndvdual effecs, u s assumed o be ndependenly dsrbued across ndvduals. LLC esmae o hs regresson usng pooled OLS. In hs regresson deermnsc componens are an mporan source of heerogeney snce he coeffcen of he lagged dependen varable s resrced o be homogeneous across all uns n he panel (Barber, 2006). Accordng o Levn e al., (2002) LLC es sasc performs well when N les beween 10 and 250 and when T les beween 5 and 250. If T s very small, he es s underszed and has low power. We can say ha he es can be appled for mos macro panels (Nell and Zmmermann, 2011). IPS es allows for resdual seral correlaon and heerogeney of he dynamcs and error varances across groups and he es allows for heerogeneous coeffcens (Barber, 2006). IPS compue separae un roo ess for he N cross-secon uns. The null and alernave hypohess of IPS may be specfed as follows; he null hypohess s: H0 : β = 0 for all Agans he alernave: H0 : β < 0 for = 1,,N* wh 0 < N* N H0 : β = 0 for = N*+1,,N The IPS sasc s compued from he average ndvdual ADF -sascs () accordng o N = = 1 / N I s assumed ha s..d and has fne mean and varance. IPS use Mone Carlo smulaon echnque o compue he mean and varance of. If hs sasc s properly sandardzed, s asympocally N (0,1) dsrbued. Mone Carlo smulaons reveal ha he small sample performance of he IPS es s beer han LLC es (Nell and Zmmermann, 2011). Oher es, Maddala and Wu (1999) consder defcency of boh he LLC and IPS frameworks. MW s based on a combnaon of he p-values from ndvdual ADF ess for (2)

5 052 E. J. Bus. Manage. Econ. a un roo n each cross-seconal un. The MW sasc s gven by: N 2. ln p = = 1 ρ The MW es does no depend on dfferen lag lengh n he ndvdual ADF regressons. Ths provdes he advanage over he IPS es for he MW es. Maddala and Wu (1999) and Maddala e al., (1999) proved ha he MW es s superor o IPS es (Chrsopoulos and Tsonas, 2004). Esmaon The-Two Way Fxed Effecs Model Accordng o Hsao (2003), a longudnal, or panel, daa analyss provdes mulple observaons on each ndvdual n he sample. Panel daa ses for economc research have numerous advanages over crossseconal or me-seres daa ses. Frsly, panel daa gve he researcher a large number of daa pons, ncreasng he degrees of freedom and reducng he collneary among ndependen varables. So, panel daa mprove he effcency of economerc esmaes acheved. Secondly, panel daa allow us o consruc and analyze more complcaed behavoral models han convenonal cross-seconal or me seres daa. Besdes hese advanages, panel daa provde he possbly of generang more accurae predcons for ndvdual oucomes han me-seres daa alone (Hsao, 2003). Panel daa may have group effecs, me effecs, or boh. These effecs are eher fxed effec or random effec. A fxed effec model assumes dfferences n nerceps across groups or me perods. Fxed effecs model explore he relaonshp beween he predcor and oucome varables whn an eny. Ths eny may be households, counres, frms. The model assumes all oher me nvaran varables across enes ha can nfluence he predcor varables o be consan (Torres- Reyna, 2007). u = µ + λ + v = 1,,N =1,,T Where µ denoes he unobservable ndvdual effec, λ denoes he unobservable me effec, and v s he sochasc dsurbance erm. λ s ndvdual-nvaran and accouns for any me-specfc effec ha s no ncluded n he regresson (Balag, 2005). If he µ and λ are assumed o be fxed parameers o be esmaed and v IID (0, σ ), hen he above regresson represens a wo-way fxed effecs error componen model (Balag, 2005). Fxed effecs model can be formulaed as: y = x. β + α + ε (3) ' where α denoes all he observable effecs and s group-specfc consan erm n he regresson model. 2 v α equals z '. α n he regresson (3). If z s unobserved, bu correlaed wh x, hen he coeffcen of β s based and nconssen under assumpons of 2 2 E( u ) = 0 ; E( u ) = σ all ; E( u. u j s) = 0 for s 0 and j y α0 X. β α γ ε = (4) Equaon (4) can be formulaed as a wo-way fxed effecs model conrollng for unmeasured me-nvaran dfferences beween uns and un-nvaran dfferences beween me perods. α denoes ndvdual-specfc effecs and and Pra, 2004). EMPIRICAL RESULTS γ denoes perod-specfc effecs (Worrall Table 1 shows he resuls of frs generaon panel un roo ess for he varables. As s seen from Table 1, all frs generaon panel un roo ess resuls show ha null hypohess of a un roo for boh curren accoun defcs and neres raes can be rejeced a he 5 % sgnfcance level. Thus, he wo seres have level saonary process accordng o Table 1. Tha s he mean and he sandard devaon of he varables do no change wh he me. Table 2 ndcaes he resuls of es of cross secon and perod fxed effecs. We esmae he relaonshp beween he curren accoun defcs and real neres raes usng wo-way fxed effecs esmaor. Employng he wo-way fxed effecs model wll gve relable resuls snce he esmaed probably values of boh cross secon F and perod F sasc a 0.00 are smaller han sgnfcance level a The resuls obaned from he wo-way fxed effecs are shown n Table 3. An ncrease n real neres raes wll nduce o mprove he curren accoun balance. The

6 Melha and Feyza. 053 Table 1. Panel Un Roo Tess ( ) Seres LLC IPS ADF PP CA * * * * Prob.value RINT * * * * Prob.value Noe: Probably values of he varables are repored as prob.value. * denoes he rejecon of he null a he 5% level. Table 2. Tes of Cross-Secon and Perod Fxed Effecs Effecs Tes Sasc d.f. Prob. Cross-secon F (20,579) Cross-secon Ch-square Perod F (29,579) Perod Ch-square Cross-Secon/Perod F (49,579) Cross-Secon/Perod Ch-square Table 3. The Resuls for Two-way Fxed Effecs Model Dependen Varable: CA β -rao sd.error prob. RINT C coeffcen of real neres rae s sgnfcan and posve. Hence, we can say ha he real neres rae s an mporan deermnan n mprovng he curren accoun balance. Concluson In hs paper, we nvesgaed he mpac of he real neres raes on he curren accoun defcs. For hs purpose, we esmaed he wo-way fxed effecs model over he perod from for a sample of 21 OECD counres ha are hgh ncome economes. Frsly we nvesgaed wheher here exss un roo among he panel seres. We found ha all varables are I (0), ha s, hey are level saonary varables. The emprcal evdence n hs paper clearly ndcaes ha he real neres raes are mporan deermnans on he curren accoun defcs. Our nvesgaon of he real neres raes lead us o conclude ha here exss a srong and posve relaonshp beween he real neres rae and he curren accoun balance. Ths fndng s mporan for he polcymakers snce polcymakers havng he am of srugglng wh he curren accoun defcs may acheve hs by decreasng he real neres raes. REFERENCES Abbas SMA, Hagbe-B J, Faas AJ, Mauro P, Velloso RC (2010). Fscal Polcy and Curren Accoun. IMF Workng Paper, WP/10/121 Akdş M (2006). Para Teors ve Polkası. 2 nd Publshmen, Gaz Booksore, Ankara. Anoruo E, Elke U (2008). Asymmerc Dynamcs n Curren Accoun- Ineres rae Nexus: Evdence from Asan Counres. Invesmen Managemen and Fnancal Innovaons, 5(4): Balag B (2005). Economerc Analyss of Panel Daa, Thrd Edon, Chcheser: John Wley & Sons, Ld. Barber L (2006). Panel Un Roo Tess: A Revew, Quadern del Dparmeno d Scenze Economche e Socal, Sere Rossa, n.43, Unversà Caolca del Sacro Cuore, Pacenza. Bergn PR, Sheffrn SM (2000). Ineres Raes, Exchange Raes and Presen Value Models of The Curren Accoun, Econo. J., 110: Bernhardsen T (2000). The Relaonshp Beween İneres Rae Dfferenals and Macroeconomc Varables, A Panel Daa Sudy for European Counres. J. Inl. Money. Fnanc., 19:

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